Tariffs—Reverse Gear in the Economic Transmission

2018-03-19The US government thinks tariffs will shift the economy into a higher gear. But they'll actually shift it into reverse...

It’s been said many times, and quite truthfully, that politicians typically think no further than the next election—and that their own retention of power is of far greater importance than their country’s overall welfare.

No surprise, then, that when a country is on the ropes economically, political leaders gain and/or retain office, largely on the strength of promising a return to prosperity. It matters little whether they can actually deliver on that promise—their insistence that they have “a plan” is often sufficient for success at the polls.

Donald Trump is an excellent example. His central campaign slogan was “Make America Great Again,” and whilst he was quite vague as to the details through which this might be accomplished, he did focus heavily on the Chinese as the bogeyman that was “robbing America of its jobs.”

Again, no surprise, then, that Mister Trump has recently approved a 25% tariff on the importation of steel and aluminium, ostensibly to pare back Chinese exports to the US and to bring back jobs.

Of course, it’s quite true that industrial metals play a major part in the prosperity of a country. Indeed, construction is the economic bellwether of any growing economy, and industrial metals are a primary component in that growth.

With prosperity comes increased spending on products, generating increased production of those products. This has an immediate knock-on effect in the construction of industrial buildings, most of which are made of steel. In addition, developers build more offices and flats—multi-storey steel buildings. And more shop space is needed—shopping plazas located in new pre-engineered steel structures. Stand-apart homes, too, are created from steel stud framing.

So, let’s look at a few numbers. The tariff claims to be aimed at China, although the US buys only 4% of its steel from China. The tariff is a whopping 25%.

A full half of the steel used in the US goes into the construction of buildings (particularly pre-engineered steel buildings and multi-storey structures). Pretty substantial.

When the cost of raw steel goes up a bit, steel manufacturers typically place a rise on their prices that’s considerably above their true increase in cost—and 25% is an unusually high increase for raw steel. Just prior to the approval of the tariff, structural steel suppliers in the US announced an increase of 90% in manufactured steel. The reason given? The suppliers had no choice in their rate increase, as it had been forced upon them by the tariff.

Traditionally, developers and industrialists tend to put their expansion and development plans on hold, whenever steel prices rise. A rise in steel prices is a deterrent to business expansion. A major rise in prices translates into a major deterrent to business expansion.

If the US government wanted to put the kybosh on business expansion, it couldn’t have picked a better way to do it than to tax the importation of steel.

But surely, whatever industrial metals are imported, since a tariff will be added, US metals suppliers will benefit from the additional income? Well, no, not really. Even they will be losers for two reasons. First, their sales will plummet. Second, they are not the net recipients of the tariff revenue. The recipient would be the US government.

But, there’s a third reason why there will be no net benefit to the US industry and, in fact, virtually all Americans will be encompassed into this third loss.

Although tariffs have been promoted throughout history by politicians as being “protective,” they’re in fact destructive to the overall economy. Invariably, when one country announces a tariff, the countries that are affected quickly announce their own tariffs and a tariff war begins.

The first casualty in a tariff war is free enterprise. Prices within each country rise, without producing increased development or employment. This translates into a lower standard of living for each population, as the countries become economically isolated from each other.

But, if this is invariably the case, why on earth do politicians perennially create tariffs? Well, in addition to the irresistible opportunity to create yet another tax, politicians are aware that the idea of a “protective tariff” sounds good to those voters who may be shortsighted. And, typically, voters focus on the promise that’s being offered by the politician rather than seek to learn whether there’s supportive logic for the promise.

In 1929, US President Herbert Hoover had recently been elected. He had never been elected to a public office before, having spent his previous career as a businessman and having become wealthy in doing so. (Sound familiar?) He was elected at the height of a bull market, but in October 1929, a stock market crash brought him great criticism in the press and he needed to come up with a plan to demonstrate that he was dealing with the effects of the shattered economy.

The solution was the Smoot-Hawley tariff of 1930, which was a major increase of 19%. Far from protecting the interests of American industry, the tariff has been credited as one of the major factors in the creation of the Great Depression, following the stock market crash.

Mister Hoover was blamed for the depression by Democrats in the lead-up to the 1932 national election and the first socialist US president, Franklin Roosevelt, won by a landslide against Hoover. He became (in effect) president for life, having been elected for four terms and dying in office.

If there’s a difference between the 1930 tariff and the present one, it is that, this time around, the tariff has been put in place in anticipation of the crash. Therefore, when the economic collapse comes, it will hit harder and more suddenly than the Great Depression.

It has often been said that those who do not learn history are doomed to repeat it. This is certainly true and, in the present case, the same mistake is being made as in 1930 and for the same reason. Political leaders, when faced with an economic crisis, tend to rely on the same knee-jerk solutions as their predecessors, regardless of how badly those solutions may have played out in the past.

And so, on the eighty-eighth anniversary of the Smoot-Hawley tariff, the US government recklessly attempts to shift the economy into a higher gear—and unintentionally shifts into reverse.

All that remains is for the economic clutch to be re-engaged. We shall then watch the economic gearbox self-destruct.